This Week's Focus: Draghi's magic no longer excited the market

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Monday, 07 of December 2015

This Week's Focus: Draghi's magic no longer excited the market

At its meeting on Thursday, the Governing Council of the ECB decided to keep interest rates on the main refinancing operations and the marginal lending facility at 0.05% levels and 0.30%. At the same time, it reduced the interest rate applicable to the deposit facility by 10 basis points to stand at -0.30.

Bank lending to grow as
These measures seek to stimulate the growth of credit to households and businesses in the euro area, with the purpose of increasing the GDP and improve economic recovery. The finding that the credit is barely growing at the pace expected by the ECB discussed in our post Bank credit does not grow, for the Spanish case.

The deposit facility, ie, the money that banks deposit with the ECB instead of spending to pay, instead of pay has a cost. This measure implies a disincentive for banks to deposit money with the ECB instead of lending to households and businesses, and clearly aims to stimulate credit growth. There is a clear link between increased credit and economic growth, but often occurs late.

For now, the measure has not been effective. Among the reasons they are offset increases in capital that banks have in the new solvency rules (Basel III), the deleveraging process that began with the 2008 financial crisis, the high unemployment, technological changes and its impact on employment and increased uncertainty about the impact of increased global economic and financial imbalances in various parts of the world. Furthermore, increasing disputes magnifies this process.

More euros to buy debt
The unorthodox measures were also expanded in the ECB meeting. The official aim of unconventional policies is to increase inflation to the level of 2% in the medium term (now well below this level). However, these measures seek cheaper funding for states, so that the increase in public debt as a result of the deficits incurred after the crisis does not involve a large increase in the financial burden on public budgets requiring further cuts and compromise future economic growth. Thus, the ECB's intervention as a buyer of bonds on the secondary market at 1.5 billion (trillion) euros in total, will have an indicative amount of 60.000 million a month until at least March 2017.

The unorthodox policies have a direct impact on the valuation of financial assets, both fixed income and equities, so its influence on financial markets is important. Given the volume of purchases and avoid out of the market to all participants, the ECB has extended the objectives of the asset purchase program (Asset Purchase Program) to debt issued by government agencies of local and regional level, but without specifying the amounts and specific issuers.

And the markets did not like the measures
The effects of market measures were immediate: European stock markets were down 3% on average and the euro appreciated more than 3% in a few minutes, as is the movement of further appreciation in a day of the last six years. At the same time, the interest rate of 10-year German Bund rose 0.20%.

The impact on the financial market was therefore the opposite of the desired. We say the opposite because: 1) the cost of financing for euro states, rose in the wake of the Bund; 2) the financial wealth of households (via bag) fell in a few hours and 3) the competitive advantage of the currency fell. All these impacts in the short term have little effect unless endure over time, but makes it clear that the ECB does not always have to market ally. Draghi's magic, it seems that for now vanished.